Cryptocoins: Inherently More Valuable Than Startup Equity?

At the time of this post, Status.im’s crytpocoin is trading on public exchanges at a network value (network value is the cryptocoin equivalent of market cap for a public co) of $163M. It is basically a pre-launch messaging app. I don’t think there’s any debate that this asset is not priced correctly. If Status were a startup Delaware C-corp selling preferred equity to venture capitalists, it would be valued south of $10M and most smart investors I know would pass regardless of price. Issuing coin instead of equity has enabled a valuation premium of 1000% or more. So what’s the deal?

It’s important when thinking through this question to recognize that coins are not a proxy for shares in all cases, and often, depending on the design, only a portion of the value created by the project flows through to the corresponding coin. Numerai and Numeraire is a good example of the market’s confusion around this point. Numerai is a hedge fund that trades on crowdsourced predictions from data scientists. Numeraire is an ERC 20 coin that is used to reward those data scientists for contributions, and also to incentivize them to represent their confidence in their models accurately via a stake mechanic. The value of all the Numeraire coins in existence is roughly equal to the net present value of the future cash payouts to data scientists who are contributing…and that value is substantially less than the value of the Numerai hedge fund itself. In fact, cash payouts are not even tied to firm profits at the protocol level. They are discretionary. Numerai is an awesome company. The founder is really smart. Numeraire is an elegant design (you can read their paper here), but when it floats and trades up to $175M network value on the first or second day, while cash payouts to data scientists are currently in the range of $1M per year, you know that not everyone is understanding the difference between equity in a project and ownership of a coin. fwiw, I hope to buy Numeraire if it starts to trade at about a $10M network value.

Ok, so with the distinction drawn between equity and cryptocoin, a question I have been asking myself is whether or not there is anything inherently more valuable about owning the coin in a blockchain project (let’s say for purposes of this question that all of the value in the project flows through to the coin) vs owning preferred equity in what would be the corresponding startup organized as a Deleware C-Corp. I think a lot of people feel the answer is yes, but why? One clear input that would command a premium for coin vs equity in a startup is liquidity. If I am buying pre-ICO coin, or even coin at onset, my ability to sell my position immediately or within a short time frame makes me willing to pay more than illiquid startup equity i have to hold for many years. I’m not sure how much of a premium to apply for this privilege, but if Status were valued at $10M as a startup pre launch messaging app, maybe this increased liquidity would command a 2x premium? I think that might even be generous, but I can at least wrap my head around a $20M valuation for that reason. I still wouldn’t be a buyer, but someone who believed in the plan and design could maybe justify that price.

So is there anything else, other than increased liquidity, that justifiably commands such a steep premium, from even $20M to $163M? Maybe on a project by project basis, there are some unique properties of the coin’s design that make it more attractive than the value that might be captured by owning equity in a company with similar ambitions and product roadmaps, but across the entire asset class there’s only one other thing I can think of that is driving premium pricing: a second use case for the coin that has nothing to do with it’s utility in the network it governs.

That second use case, I believe, is Bitcoin’s primary use case: store of value. Bitcoin feels like a pure play and likely long term winner of the “store of value” use case. You might hear people talk about Bitcoin as “digital gold,” a place to park your cash, a place to escape the controls of your unfriendly government, a place for capital flight, etc…whatever that use case, Bitcoin does that and increasingly it seems likely only that…store of value is the killer application of Bitcoin…all the other applications that people have talked about for BTC and hoped for in the past (i.e. digital commerce, peer to peer micropayments, etc)…I think are more likely to be owned by separate protocols and coins specifically designed for those cases.

So right now all these other protocols, Status included, I think are borrowing some of the store of value use case from Bitcoin, commanding a premium to their true utility value, by capturing dollars seeking store of value, and the question I have is should they be? Do they deserve a part of this use case? Is there an argument for many coins acting as digital store of value or only one or a few? Is it better to be a pure play store of value (like paper money for example), or to couple a store of value with an industrial application (like gold…which makes pretty jewelry in addition to a good place to park your cash). I am not an economist, and i’m sure there are very good reasons why we used to store value in things with utility, and then we decoupled the two at some point with money, so now that store of value is digitized, do we want to store our value in a coin that has utility within say a messaging use case, or would we rather store it in a vehicle that is just for storing value? I don’t know the answer to that, but my gut says there will be a small number of coins that get to own this store of value use case, and not 1000s…so a lot of that “second use case premium” we’re seeing in today’s ICO pricing will probably evaporate.

Can anybody think of other dimensions of a coin, besides these two, that justify valuation premiums relative to startup equity?

I’m not an expert in a lot of what I’m talking about. Please correct me or add to this thinking if you have the background to do so. It’s a question I’m really interested in understanding.

4 Responses to “Cryptocoins: Inherently More Valuable Than Startup Equity?”

I agree with much of what you wrote (BTC == pure store of value, ICO premium vs traditional VC probably too high), but I would quibble with the statement that new protocols like Status are borrowing from BTC’s store-of-value utility to justify their valuation.

Instead, I think the theoretical justification (not that I agree with it) for why a new protocol is worth $50m looks something like this…
* Protocol represents something of value that people do every day (i.e. store files, browse websites, play games, etc)
* Initially supply is fixed and future inflation is capped
* Initial token owners represent a smallish subset of the overall addressable population
* Therefore, the value of the token = Expected value of token = Current value (# of initial token owners * token value) + Growth expectation (Total population / initial population * P(achieving 100% market share) * Token value

To put numbers on this, let’s assume that your token represents attention/month spent on your “social network on blockchain” project. You sell $1,000 worth of tokens to 100,000 people, raising $100m in the process. A proxy for the current value of your token might be $10/user/month (current Facebook USA user). This implies that $990 premium represents discounted future value. If the total addressable user base is 2 billion (current Facebook global user base), that implies that the probability of hitting that target needs to be 4.95% to justify the $990 premium, assuming 0 inflation. Under that scenario, a rational investor should purchase the token if he/she believes the probability to be lower than 4.95%.

I’m not saying everyone is doing this math but I think it’s a useful framework to evaluate ICOs 😉

FWIW, I also dislike Numerai and Numeraire because the way that they encrypt their datasets discourages any data scientist worth their salt from participating, so their users are probably mostly beginners relying on dumb luck. But that’s a tangent…

The US Stock market as a whole is in fact trading at a premium because people see it as a long term store of value. Why else would people be happy to pay over 25x earnings (a measly 4% earnings yield). ICOs premiums are simply 10x more right now because of the excitement in the space.

In your Numerai example, it seems you are saying you’d be willing to invest in Numeraire at a 10 P/E (network value/rewards) ratio. I don’t know much about the project, but isn’t it possible that the hedge fund benefits so greatly from the increased data that they are able to increase the rewards from $1M to $20M annually within a year or two. In that scenario the current market cap would no longer be wacky.
Of course, I don’t have any clue how realistic this might be. I looked into Numeraire for a second but wasn’t able to grock the use case until reading your this post, so its nice to finally understand why it has any value at all.